Monetary policy under debate

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By FERNANDO NOGUEIRA DA COSTA*

The market seems to have realized: maintaining the current reference rate would be a serious mistake

Monetary policy is under debate in Brazil because of the restart of a new social-developmentalist government elected against neoliberalism allied with neofascism. My former professor at Unicamp, Luiz Gonzaga Belluzzo, made timely considerations about her (Economic value, 07/03/23).

The goals regime has the purpose of defining the optimal reaction rule of the Central Bank. Presumably, over time, it would strengthen the confidence of “the market” agents. By adapting its decisions in managing the short-term interest rate to the rational expectations (according to the economy of neoclassical confidence) of price makers and wealth holders, the monetary authority would obtain stability in the general price level at the expense of workers' income and employment.

Luiz Gonzaga Belluzzo quotes Michael Woodford for this author proposing the target system to aim for the stabilization of infrequently readjusted prices (sticky prices) such as administered prices for public utility services. Circumstantial fluctuations in competitive prices, subject to frequent adjustments or shocks with atypical supply shortages, should be excluded from the inflation targeting regime precisely because they are short-term booms and busts.

This inflation targeting regime should also not be concerned with fluctuations in financial asset prices as it is a transient exchange rate shock in itself. Not all goods would have their prices equally controlled by aggregate demand.

Thus, the Central Bank should adopt the core inflation stabilization target. O core inflation represents the long-term trend in the price level.

When measuring long-term inflation, transient price changes must be excluded. To this end, price index components that are often subject to volatile prices, such as food and energy, are excluded. When general monetary control is perceived as not being able to cope with, for example, seasonal dry seasons, greater emphasis is placed on tighter prices less subject to supply shocks.

But do these temporary supply shocks in the prices of raw materials and food or the untimely readjustment of administered prices not adversely contaminate agents' expectations? This would happen if the price makers always confronted their clientele disputed by other oligopolistic competitors...

In other words, “unanchored expectations” determine readjustments in all prices or at least in prices of key inputs?! This is not the case, for example, with fuel prices related to the volatility of the exchange rate and the international quotation. commodity oil beyond the control of monetary policy. An electoral policy got its downfall by forcing the states to cut their taxes.

Luiz Gonzaga Belluzzo warns: “the Central Bank's reaction must also consider the negative effects on the public debt and the nominal deficit originated by an excess in the management of the short-term interest rate”. In a situation of fiscal dominance, the rise in the real interest rate causes debt growth by raising the real cost of debt service and by reducing the demand for goods and services, especially that of workers. Therefore, it causes a drop in tax revenue and makes it difficult to obtain a primary surplus.

André Lara Resende, in turn (Economic value, 08/03/23), highlights: a successful intervention should lower future inflation expectations, lowering interest rates for longer terms, while temporarily raising interest rates for shorter terms. It is the mechanism for reducing the slope of the term structure of interest rates.

It focuses on the effect of interest on public debt. In addition to the Selic being the base to add a spread and establishing the entire structure of loan interest in the economy, it matters for monetary and fiscal policy. Why is it so high?

He also criticizes the idea that in the long run it is only determined by the expectations of debt holders, as maintained by the vast majority of media economists of “the market”. In fact, the term also results from the direct action of the Central Bank.

On a day-to-day basis, the monetary authority manages liquidity in the bank reserve market to place the Selic-market at the level of the pre-announced Selic-target. However, market idolaters defend the thesis that “interests are the result of impersonal market forces, since the Central Bank of Brazil would only determine the very short-term rate, that is, the rate for one day or overnight”.

In this preaching, the sacrosanct market would determine the interest for the longest terms, in fact, relevant both to the cost of debt and to credit conditions in the economy. Thus, the monetary authority would not be able to oppose the determination made by the market regarding interest rates for longer terms.

This term structure of public debt rates (and parameter for long-term private debt), according to Lara Resende, is known by those who have a reverential intimacy with it as “the curve”. She would be impersonal and unforgiving.

If the Central Bank tries to voluntarily reduce the basic rate – as was done in the first government of Dilma Rousseff –, the threat is the commonplace: “inflation expectations would be unanchored”. Hence, they would be reflected in the increase in long-term rates.

In the opposite direction of the fall in the basic rate, in the metaphorical jargon of the snobby rentier-merchant caste, “the curve would steepen, with lower short interest rates, but higher long interest rates”. Graphically, it is represented by a greater angle of interest inclination over time, arbitrarily extrapolated by this imagination that creates interest in the pockets of public debt holders.

Hence, all the statements by the authorities critical of the untouchable monetary policy, including those by the President of the Republic re-elected for the third time with votes from the majority of the electorate, would express a fruitless attempt to artificially reduce interest rates and, after all, would end up raising them. them. Some “spokespersons” even say “interest rates would drop, but President Lula's criticism ended up raising current rates”!

It's like accusing “infiltrated PT members” for the riot at the headquarters of the Three Powers of the Republic on January 8, 2023, the day of national shame! The imagination of these right-wing people has no limits to victimize themselves... and benefit from their lies.

Lara Resende demonstrates with data the average cost of issuances and the stock of debt to follow the Selic rate. There is, in this case, a high causal correlation between the two.

By fixing the base interest rate for one day (overnight), the Central Bank determines the first point of the curve. From then on, the treasury of each “deficit” bank, if it had not obtained a surplus in the daily cash flow, would obtain the necessary reserves to carry its portfolio of public debt securities, in the interbank market, which determines the CDI rate, used as proxy of SELIC. A portfolio selection with post-fixed securities (LFT) and/or with a price index (NTN-B) would have practically no risk, instead of speculative bets on the fall of fixed interest rates (LTN).

Estimating the successive one-day rates determined in the future by the monetary authority is an exercise in the collective imagination. Ensure that, ex post, the average cost of debt, established by the rates for the different maturities of the securities, is the consequence of its monetary policy leading the trajectory of the basic rate over time. The market follows the Central Bank, that is, “the tail does not wag the dog!”.

For Lara Resende, the focus should not be exclusively on the mythical inflation target. Incidentally, the inflation rate has been inertial at around 6% per year for almost two decades, except for two years (2015 and 2021), respectively, due to tariff shocks (over-adjustment of administered prices) and imported inflation.

The correct rate would be the one capable of allowing full employment to be achieved, without causing the economy to overheat or causing external trade deficits. As the “natural or neutral rate”, which provokes the so-called monetary balance, is hypothetical, that is, only verified ex post, after verifying to have been a passenger in time, everything else is mere speculation. Monetary policy is not science, but skill…

Lara Resende, one of the theorists of inertial inflation in Brazil, correctly states: “not all inflation is caused by excess demand. So how and why rising interest rates would reduce it is unclear.”

Adherents of the confidence economy evade the responsibility of pointing out the transmission channels of monetary policy for setting all prices. Would it be the Phillips Curve with the seesaw between inflation and unemployment? Would it be the effect on the appreciation of the national currency with the disparity of the national interest rate against the international interest rate? would be to Milton Friedman “the diffuse channels with variable lags”?

Finally, Lara Resende points out that we are facing the imminence of a credit crisis, caused by the “accounting inconsistency” (sic) of Americanas and the absurd basic interest rate, threatening to cause the financial deleveraging of companies and lead the Brazilian economy to a recession or a new depression. The market seems to have finally realized: maintaining the current reference rate would be a serious mistake.

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Support and enrichment network (Available at https://fernandonogueiracosta.wordpress.com/2022/09/20/rede-de-apoio-e-enriquecimento-baixe-o-livro/).

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